The author is a Forbes contributor. The opinions expressed are those of the writer.

Loading ...

Loading ...

This story appears in the {{article.article.magazine.pretty_date}} issue of {{article.article.magazine.pubName}}. Subscribe

A Cypriot man holds a banner against the EU bailout deal and German Chancellor Angela Merkel's call for Cyprus to follow economic reforms outside the parliament building in Nicosia on March 18, 2013. (Image credit: AFP/Getty Images via @daylife)

Dig deep into the hyperbole surrounding the EU-Cyprus crisis and you find yet more hyperbole: It’s the end of deposit insurance, the end of the Euro and of Europe, the beginning of massive bank runs, the complete loss of credibility for the mandarins of global finance. Of course it is none of these things, but it is a little bit of each. Should you be scared? Maybe not, but worried!

Let us reverse-engineer the Cyprus case to get the proper perspective. Cyprus was expected to impose a levy on all deposits in Cypriot banks for the purpose of bailing said banks out, which are otherwise at risk of failure and disorderly bankruptcy. This proposed levy is higher even than the robust interest rates paid on deposits in those banks, and amounts to a de facto confiscation of part of depositor’s principal. Understandably many of those depositors would rather convert to cash than absorb the cut.

Cyprus’ banks need bailing out because, among other things, they were not very diversified in their investments, which is to say: overinvested in Greek debt. It can’t have helped to promise those enthusiastic interest rates, meant to attract foreign deposits, including lots from Russians (private and government deposits)—some of very dubious pedigree.

Cyprus itself, we are told, lacks the wherewithal to bail out its banks itself. This is complicated by the fact that Cyprus’ own government debt is mostly held by those banks. (That puts a whole new spin on the old Keynesian saw, “we owe it to ourselves”.) Still, that doesn’t mean they can’t allow some institutions to fail or consolidate under Cypriot law, allocating the costs of those failures among the government, shareholders, and depositors… even Cypriot taxpayers, if it comes to that. Nor does it stop them from recruiting an army of international risk-taking investors to fund a bailout, however tough its terms might be.

After the Cypriot parliament immediately and overwhelmingly rejected the bank-deposit tax, its government started looking at a hodge-podge of options to secure EU support, including a possible buy-in from Russian energy giant Gazprom.

Cyprus is an EU- and a Eurozone member, which is where Europe’s official institutions come in. Europe does not want any Eurozone member to go bankrupt: it looks bad and worse, it demonstrates that being in the Euro-club is no guarantee against financial crisis. Like the Roach Motel, you can check into Europe but you can’t check out. So to save the Euro, Cyprus’ banks must be saved. For the first time though, the mighty EU Troika (EU, European Central Bank, and Christine Lagarde’s omniscient IMF) insisted that bank depositors, who clearly knew they were taking risks going for those high returns, and many of whom are (uninsured) Russians engaged in money laundering anyway, pay a large chunk of the bailout cost before the Troika would fork over the rest.

There you go: The hyperbole and the outrage come not from what is being done (the Troika bailing out Cyprus) but from the how. For the first time Europe/Troika are demanding the imposition of bailout costs, directly, on individuals—some Cypriot, many foreign—who entrusted their funds to Cyprus’ banks. That Cyprus itself was expected (under duress) to enact the deposit tax is almost irrelevant, since the Troika is really running this show. This is true however the scenario plays out: Now that the Cypriot parliament has refused to enact the ‘depositor tax,' the Troika is already signaling that it might not even agree to the alternative Cypriot rescue proposals coming out of Nicosia.

Whatever happens next, in choosing the deposit tax as its preferred route to a bailout the Troika makes clear it is wholly indifferent to the rule of law. If it cared about the law, it would suggest that Cyprus explore every option under its own laws to close down and consolidate banks as necessary—and judge how parties-in-interest shoulder the costs. An EU-Troika bailout in the wake of such a shakeout would have more credibility and a less terrorizing effect.

It’s hard to escape the notion that a bit of terrorizing is part of the Troika’s agenda here, as if to suggest a belated moral stand against money-laundering and really bad financial governance. But moral stands are risky and have a way of bouncing back against the chief moralist in nasty ways. In this case, the Troika puts in question not just the credibility of deposit insurance per se but the safety of deposits in financial institutions against state confiscation.

The Troika also puts into question its ability of sound judgment. If even a small minority of global investors concluded that it cannot be trusted, the assumption that they can manage the Euro-crisis would go right out the window. And along with that would go the false armistice between governments and investors that has papered over the underlying financial crisis since 2008.